These 4 Measures Indicate That Lions Gate Entertainment (NYSE:LGF.A) Is Using Debt In A Risky Way

By
Simply Wall St
Published
March 16, 2022
NYSE:LGF.A
Source: Shutterstock

Howard Marks put it nicely when he said that, rather than worrying about share price volatility, 'The possibility of permanent loss is the risk I worry about... and every practical investor I know worries about.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Lions Gate Entertainment Corp. (NYSE:LGF.A) does use debt in its business. But should shareholders be worried about its use of debt?

Why Does Debt Bring Risk?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. If things get really bad, the lenders can take control of the business. However, a more common (but still painful) scenario is that it has to raise new equity capital at a low price, thus permanently diluting shareholders. Having said that, the most common situation is where a company manages its debt reasonably well - and to its own advantage. When we examine debt levels, we first consider both cash and debt levels, together.

See our latest analysis for Lions Gate Entertainment

What Is Lions Gate Entertainment's Net Debt?

The image below, which you can click on for greater detail, shows that at December 2021 Lions Gate Entertainment had debt of US$3.67b, up from US$3.14b in one year. However, it does have US$314.4m in cash offsetting this, leading to net debt of about US$3.35b.

debt-equity-history-analysis
NYSE:LGF.A Debt to Equity History March 16th 2022

How Strong Is Lions Gate Entertainment's Balance Sheet?

Zooming in on the latest balance sheet data, we can see that Lions Gate Entertainment had liabilities of US$1.98b due within 12 months and liabilities of US$3.82b due beyond that. Offsetting this, it had US$314.4m in cash and US$494.5m in receivables that were due within 12 months. So its liabilities outweigh the sum of its cash and (near-term) receivables by US$4.99b.

When you consider that this deficiency exceeds the company's US$3.34b market capitalization, you might well be inclined to review the balance sheet intently. Hypothetically, extremely heavy dilution would be required if the company were forced to pay down its liabilities by raising capital at the current share price.

We measure a company's debt load relative to its earnings power by looking at its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and by calculating how easily its earnings before interest and tax (EBIT) cover its interest expense (interest cover). Thus we consider debt relative to earnings both with and without depreciation and amortization expenses.

Weak interest cover of 0.22 times and a disturbingly high net debt to EBITDA ratio of 10.8 hit our confidence in Lions Gate Entertainment like a one-two punch to the gut. The debt burden here is substantial. Even worse, Lions Gate Entertainment saw its EBIT tank 86% over the last 12 months. If earnings continue to follow that trajectory, paying off that debt load will be harder than convincing us to run a marathon in the rain. The balance sheet is clearly the area to focus on when you are analysing debt. But it is future earnings, more than anything, that will determine Lions Gate Entertainment's ability to maintain a healthy balance sheet going forward. So if you're focused on the future you can check out this free report showing analyst profit forecasts.

Finally, while the tax-man may adore accounting profits, lenders only accept cold hard cash. So the logical step is to look at the proportion of that EBIT that is matched by actual free cash flow. In the last three years, Lions Gate Entertainment created free cash flow amounting to 6.4% of its EBIT, an uninspiring performance. For us, cash conversion that low sparks a little paranoia about is ability to extinguish debt.

Our View

On the face of it, Lions Gate Entertainment's interest cover left us tentative about the stock, and its EBIT growth rate was no more enticing than the one empty restaurant on the busiest night of the year. And furthermore, its level of total liabilities also fails to instill confidence. Considering all the factors previously mentioned, we think that Lions Gate Entertainment really is carrying too much debt. To our minds, that means the stock is rather high risk, and probably one to avoid; but to each their own (investing) style. The balance sheet is clearly the area to focus on when you are analysing debt. However, not all investment risk resides within the balance sheet - far from it. To that end, you should be aware of the 1 warning sign we've spotted with Lions Gate Entertainment .

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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